Do Low Interest Rates Mean the Massive U.S. National Debt Doesn't Matter?
With U.S. interest rates plunging, some liberals are making the following argument: “Why worry about the exploding U.S. national debt? If markets aren’t worried, why should I be? Time for more stimullus.”
In fact, that seems to be just the argument that holds sway at the Obama White House. Except, of course, what we are seeing here is a flight to relative safety as the EU debt crisis continues to rage.
But that’s a mistake. As economists Carmen Reinhart, Vincent Reinhart, and Kenneth Rogoff warn in their new debt study, governments shouldn’t wait for financial markets to freak out before cutting debt:
We identify 26 episodes of public debt overhang–where debt to GDP ratios exceed 90% of GDP–since 1800. We find that in 23 of these 26 episodes, individual countries experienced lower growth than the average of other years. Across all 26 episodes, growth is lower by an average of 1.2%. If this effect sounds modest, consider that the average duration of debt overhang episodes was 23 years. In 11 of the 26 high debt overhang episodes, real interest rates were the same or lower than in other periods. …
Contrary to popular perception, we find that in 11 of the 26 debt overhang cases, real interest rates were either lower or about the same as during the lower debt/GDP years. Those waiting for financial markets to send the warning signal through higher interest rates that government policy will be detrimental to economic performance may be waiting a long time.”
This observation fits well with one now being made by Eurasia Group. As the consulting firm sees things, the U.S. will continue to be able to finance its deficit and debt cheaply in part because of continued global safe haven status. “But while this is a benefit, it also ‘curses’ the U.S. into a period of fiscal complacency.” As long as rates are low, there will be little pressure for a “grand bargain” to cut debt, according to the firm.
But as Reinhart, Reinhart, and Rogoff show, that approach may doom America to years or decades of subpar economic growth.
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Feb '11
Re: Do Low Interest Rates Mean the Massive U.S. National Debt Doesn't Matter?
James, this study merely shows correlation, which I am not arguing against, but you might want to read this Reason article for causation: http://m.reason.com/26821/show/fbe07972f973e9c6acc227a1bd00786a&t=fcqs8pj8u0od3qkoqs1h3d91l2
Edited on June 1, 2012 at 12:40amA quote, and close what my father told me just before I read the article, " speculating that investors are betting the dollar will win the tallest-midget contest by becoming the last currency to fall."
May '12
Re: Do Low Interest Rates Mean the Massive U.S. National Debt Doesn't Matter?
Good article and analysis.
The issue of dealing with the debt is that there is little or no warning before the collapse. Once it becomes obvious that action must be taken the time for any action other than default ise passed - see Argentina, Greece, soon Spain, etc. Of course in hindsight everyone is an economic genius and saw it coming.
This fact will be exacerbated here in the U.S. when the time comes to head for the exits there will be many more trying to get through the door.
The extremely low interest rates, especially at the long end of the curve, 10 years+ have driven the value of Treasuries to record levels and any rise in interest rates will crush the value of those same securities and I think it will unwind quickly.
That is why it is so imperative to deal with the $16Trillion elephant in the room now while we still can because by the time the pain shows up and there is a consensus to deal with the problem it will be well past too late.
May '12
Re: Do Low Interest Rates Mean the Massive U.S. National Debt Doesn't Matter?
I would also add that while liberals are using this to prop up more progressive deficit spending there have also been plenty of 'conservatives' that don't seem to think our debt is a pressing issue. I recall VP Cheney's quote "deficits don't matter" and even Congressman Ryan's supposedly radical budget doesn't balance for almost a decade, if then and adds trillions more to the debt.
Sep '10
Re: Do Low Interest Rates Mean the Massive U.S. National Debt Doesn't Matter?
For many leftists--environmentalists in particular--subpar economic growth isn't a bug, it's a feature. Especially if it punishes the United States.
Re: Do Low Interest Rates Mean the Massive U.S. National Debt Doesn't Matter?
I think the WH, etc. vastly underestimate how quick markets can turn on you. No sense of urgency
Mar '12
Re: Do Low Interest Rates Mean the Massive U.S. National Debt Doesn't Matter?
Google turned up a 2004 Washington Post article referencing a 2002 comment by Cheney to Paul O'Neil saying deficits don't matter (must have been in O'Neil's book). Post 9/11, with the economy still recovering from the attack and the nasdaq bubble, his comment had an entirely different set of circumstances surrounding it than today. Does it excuse all the dumb spending of the Bush era - of course not. But context is important, and to use a comment from 10 (long) years ago to justify the Pelosi/Reid/Obama spendathon since 2006 is a stretch. Typically democratic, but still a stretch.
Apr '12
Re: Do Low Interest Rates Mean the Massive U.S. National Debt Doesn't Matter?
If you understand the principles (read Bastiat or Hayek), you never need to worry about whatever twisted facts the libs have come up with this week. Their premises are faulty; nothing good follows from bad premises.
If modern economics were the science of medicine, then we're still in the stage of bleeding patients. When they improve on their own, the looters take credit. If they deteriorate, the looters say the patient should've been bled more.
Until these "learned men" recognize that "bleeding" the economy is a stupid idea, we're all going to suffer.
Edited on June 1, 2012 at 9:54amJul '10
Re: Do Low Interest Rates Mean the Massive U.S. National Debt Doesn't Matter?
Did you see where, under Obama, for the first time, US Treasury bonds were offered but not bid on in auction? The reckoning comes when a US structurally dependent on a flow of credit must monetize the debt because there are no takers. And unemployment-suppressed wage levels do not keep pace with food and fuel inflation, crashing the standard of living.
You are here. And it will only get worse until the Parties of Washington are cleared out and the issues addressed.
Aug '10
Re: Do Low Interest Rates Mean the Massive U.S. National Debt Doesn't Matter?
If the argument is "markets aren't worried about inflation, why should the Fed worry?" then they have a deep misunderstanding of monetary history. Inflation does not tend to increase linearly, and the descent into rapidly accelerating inflation is exponential. Trying to stop it is like trying to catch falling knives.
If the argument is "debt qua obligations do not matter", then the wrongness becomes more... nuanced. Neo-chartalists have a good point that fiat money allows a government to do all kinds of irresponsible things, which should be theoretically impossible under the classical understanding of money as a store of value. But, like Keynesians, their bad prescriptions outweigh their good descriptive analysis.
If we treat the dollar as a meaningless token, a mere tool of fiscal policy, then markets truly don't matter. The only thing that matters is manipulating financial system players such that holding dollars is crucial to their institution's survival.
It would all blow up eventually. But meanwhile, it enables "heroic" policy.
Jan '12
Re: Do Low Interest Rates Mean the Massive U.S. National Debt Doesn't Matter?
What I find interesting is that a lot of the people making this argument (such as P. Krugman) are also inherently distrustful of markets that operate solely in the private sphere and have a tendency to go haywire (recent housing boom and bust, dot-comt boom and bust, etc.). That is why those markets require regulation according to them. They don't apply that same skepticism to the gov't finance spere.
Also, the "market" in this context is not exactly a market as the Fed has been buying up bonds to drive down rates not only through the various QE programs but under their normal course operations.
Mar '12
Re: Do Low Interest Rates Mean the Massive U.S. National Debt Doesn't Matter?
I wonder if Japan 1990-2010 was one of the 26 countries in the study James mentions. Regardless, doesn't the interest due on the ever-growing debt, even at relatively low rates, still begin to gobble up frighteningly large portions of the federal budget? It may be a vain hope, but could that colossal interest expense alone not send the signal to the federal government to cut debt?
Sep '10
Re: Do Low Interest Rates Mean the Massive U.S. National Debt Doesn't Matter?
Insolvency comes slowly, then suddenly.
May '12
Re: Do Low Interest Rates Mean the Massive U.S. National Debt Doesn't Matter?
Chris
But context is important, and to use a comment from 10 (long) years ago to justify the Pelosi/Reid/Obama spendathon since 2006 is a stretch. Typically democratic, but still a stretch. · 12 hours ago
The context is known and irrelevant. The DC solution to every issue is deficit spending and Keynesian wizardy be it 9/11, GM, Fannie Mae, etc. It is hypocritical to claim conservatism and ignore our debt.
There is no excuse for the Reid/Pelosi spendathon, but they told us up front that is exactly what they intended to do. I don't like or support it, but they tell the truth. Republicans claim the mantle of fiscal conservatism always and then get to DC and forget all of it.
Oct '10
Re: Do Low Interest Rates Mean the Massive U.S. National Debt Doesn't Matter?
Bottom line; We might be able to outrun the rest and be further ahead of the alligator, but in the end, he can still outrun us.
Re: Do Low Interest Rates Mean the Massive U.S. National Debt Doesn't Matter?
Exactly right; Greenspan just made a similar point on CNBC warning of a rate spike despite slow growth
May '10
Re: Do Low Interest Rates Mean the Massive U.S. National Debt Doesn't Matter?
James Pethokoukis: Exactly right; Greenspan just made a similar point on CNBC warning of a rate spike despite slow growth · 32 minutes ago
THAT, my friends, should scare the poop out of everyone. Once we either can't float enough debt, or have to pay significantly higher rates in order to do so, we are on the Road the Greecedom...
Jun '11
Re: Do Low Interest Rates Mean the Massive U.S. National Debt Doesn't Matter?
Nassim Taleb's booker is about to get a lot of phone calls. Just in time to promote Antifragile!
James Pethokoukis: Exactly right; Greenspan just made a similar point on CNBC warning of a rate spike despite slow growth · 44 minutes ago
May '10
Re: Do Low Interest Rates Mean the Massive U.S. National Debt Doesn't Matter?
While we have had periods of working off debt while maintaining low interest rates, there are some significant differences between our current situation and previous events.
1. We actually did bite the bullet in previous periods to work down excessive debt - I see no political will anywhere to do the same now.
2. There has never been a period with such sovereign debt/insolvency on a global scale. Our rates could well go up through a problem in Europe or Japan at a moments notice.
3. We were tied to a gold standard that limited the amount of liquidity Govt. was able to inject. If and when money velocity picks up, given the many trillions of currency units injected everywhere over the last X years, we can add serious to (in some places) hyper-inflation to our economic and personal wealth headwinds.